Oil Shocker

The drop in world demand for oil has sent prices to their lowest levels in nearly two years. With winter on the way, can those deep discounts hold?

By Jennifer Barrett

NEWSWEEK WEB EXCLUSIVE

Oct. 19 — In the hours after terrorists attacked the World Trade Center and the Pentagon on Sept. 11, gas prices at some stations nearly doubled. The scene at gas pumps around the country was eerily reminiscent of those during the oil embargo of the 1970s.

LINES OF CARS stretched for blocks as drivers, fearful of a potential supply crisis, rushed out to fill up their tanks. Some station owners capitalized on that fear, increasing prices to as much as $5 a gallon. Across the country, governors promised to prosecute for price gouging. In South Carolina, Gov. Jim Hodges signed an executive order making exorbitant price increases on essential items like fuel a criminal offense.

Just a day later, the warning seemed unnecessary.
Oil and gas prices have steadily slid since the initial spike. Regular unleaded gas now sells at an average of $1.30 a gallon nationwide, 16 percent lower than a year ago—and half what it was at some stations immediately after the September attack. After peaking at $30 a barrel in the first 24 hours after planes hit the World Trade Center, crude oil prices slipped as well, falling $4 a barrel on Sept. 24, the largest one-day price decline in a decade. Oil prices now hover at around $22 a barrel, the lowest level in nearly two years.

“Why the big drops? Even before the terrorist attacks, prices had begun to fall because of the global economic slowdown. That downward trend picked up steam after Sept. 11, mostly because of job losses and the sharp drop in commercial air travel that followed. OPEC, the Organization of Petroleum Exporting Countries, can also take some of the credit. Saudi Arabia, the world’s largest oil producer and a U.S. ally, was quick to assure anxious Americans after the attacks that the oil cartel would keep production up even if prices came down. “They’re concerned with how they’re seen now, they don’t want to be seen as taking the side of the terrorists by cutting production to jack up prices,” says Tim Evans, energy analyst at IFR-Pegasus. “Right now, it’s not OPEC’s policy that is hurting demand, it is demand that’s hurting OPEC.”

The International Energy Agency had initially projected that demand would grow by 1 million barrels per day this year. After the attacks, the agency revised its forecast again, saying it now expects overall demand growth to be just about 100,000 barrels per day more than last year, the lowest growth rate since the early 1980s. Jet fuel accounts for most of the decline. (The increase in military demand for jet fuel since the attacks on Afghanistan began has not been enough to offset the tremendous drop in demand from commercial airlines. Jet-fuel demand fell 20 percent after the attacks and analysts say it is unlikely to recover anytime soon.)
Demand for gasoline is also down to about the same level as a year ago. And the price of distillates like heating fuel should remain lower since the country has a surplus in distillate stocks—inventories are 7 million barrels above last year’s levels—and long-term weather forecasts predict that temperatures through year’s end will be warmer than they were last year.

Prices have continued to decline even after American jets attacked targets in Afghanistan, primarily because that country does not produce much oil and OPEC has been wary of cutting production during the assault. “Economically speaking, in the long run, who might end up being hurt the worst from the destruction of the World Trade Center?” asks Phil Flynn, senior market analyst at Alaron Trading Corp. in Chicago. “If you said OPEC, you just might be right.”
Some OPEC members—most notably, Venezuela—are openly demanding a production cut to try and lift prices back into the mid-$20s. But others worry that if they cut production, they’ll lose market share. And they might not be able to regain it, as the United States focuses on developing alternative sources and Russia offers up the use of its oil fields. “OPEC is in a Catch-22 because the last thing they want to do is create disruption with the U.S. by raising prices when the world’s economies are falling apart and we’re at war with Afghanistan,” says Bruce Lanni, oil analyst at A.G. Edwards & Sons, who predicts the oil cartel will grit its teeth and keep production steady for at least three to six months.

What happens if the antiterrorism efforts target Iraq? Under the oil-for-food program, Iraq has been exporting about 2.3 million barrels per day. Saudi Arabia has said it could produce an additional 3.1 millions barrels of oil per day. Still, Lanni predicts prices will spike if the war on terrorism spreads from Afghanistan into other oil-producing nations. If the conflict continues to spread, OPEC members may find themselves caught up in a battle for their allegiances. “Things could spin out of control if the coalition breaks because of these conflicts,” says Flynn.

OPEC’s 11 members also include Iran, Libya, and Algeria—where terrorist cells with connections to Osama bin Laden’s Al Qaeda network have been identified. Unrest in Indonesia, a Muslim country and OPEC member, could also affect oil supplies. About 13 percent of crude oil exports pass through Indonesian waters, Lanni says, and any disruptions could have an immediate effect on oil prices. “There are a lot of these intangibles out there, yet the market is completely ignoring this,” adds Lanni. “That could prove to be a mistake.”